What’s Next for Ethereum’s Killer App, the ICO?

This article is provided for information and education purposes only and is not intended as investment advice. Readers are encouraged to do their own research and consult a professional before making any investment decisions.

The Initial Coin Offering (ICO) has been a fundamental part of crypto startups since their rise in popularity during 2017 and was largely responsible for the subsequent cryptocurrency bubble. Startups or projects creating new currencies, services or apps launch an ICO to attract investors with an established digital token (Ethereum, Bitcoin etc.) and in exchange investors receive new tokens that they generally believe will provide a future return on their investment. This is roughly the equivalent of mainstream commerce’s Initial Public Offering (IPO) as a way of raising investment capital, except ICO tokens issued by blockchain businesses allowed access to the startup’s product or service, rather than representing any claim of ownership in the venture.

ICOs have often been the preferred means of crypto startups seeking investment because they bypass the onerous process of satisfying regulatory requirements and dealing with traditional venture capitalists. While the speed, ease of raising money, and exiting at will within the ICO structure have shown tremendous potential versus traditional capital raising methods, absent general regulatory checks and balances this doesn’t necessarily translate to mainstream business appeal where security, accountability and stability are sought after.

Now that Bitcoin has fallen more than 80% just one year after it’s meteoric rise to nearly $20,000 USD, the blockchain startup culture is entering a daunting but exciting phase where projects must either boom or bust, paralleling the 1990s internet bubble collapse.

The evidence to suggest this outcome is piling up. Ethereum’s native token “Ether” has fallen more than 90% from its high down to $125, Bitcoin continues to flounder against the US Dollar, and the declining value of crypto treasuries held by blockchain startups are seeing even the most established industry outfits laying off staff in an effort to deploy their capital more efficiently.

The future, and perhaps the end of ICOs was a significant theme at last year’s Distributed 2018 conference in San Francisco, as many would-be investors watched the knife fall as if in slow motion, trying to find their perfect moment to attempt to catch it. But why the collapse?

There are multiple intersecting reasons, and just as many points of view. One is the threat of punitive action by regulators in various national jurisdictions, another is that the bubble of investor over-exuberance was the outlier, and not the collapse — with the fall representing a reversion to fairer value. Total ICO investment in December 2018 fell to levels not seen since May 2017 - that is, when the boom first took flight to precipitate Bitcoin and Ether’s explosive rise in the first place.

Key indicators suggest that a sustainable consumer-led recovery isn’t going to ride up on a white horse, deus ex machina, and save the industry in the immediate future. This matters because there won’t be a mainstream uptake of cryptocurrencies until merchants begin to accept them and when blockchain businesses stabilize with sustained success in selling their services and products to consumers, not just tokens.

As it stands, despite its ubiquity and namecheck cachet, blockchain has minimal uptake or current usefulness in consumer markets. Most startups that tout it don’t even need it. Business acumen and hard work are what will lead to adoption - ‘build it and they will come’ - but thus far most consumer engagement with ICOs or blockchain businesses has not been with the startup’s product, but rather gambling with the financial instrument that underpins its economy instead.

If currency was the first ‘killer app’ for blockchain, the ICO could be argued to be the first popular consumer product, even if assisting startups to get off the ground was secondary to the primary consumer benefit of fast casino-like entry and exits that they permitted.

The ICO phenomena attracted a slew of investment into the Ethereum network’s native cryptocurrency Ether, as it was the prevailing de facto token used for ICO investing, and Bitcoin for its role as a precursor to acquiring Ether. This precipitated the explosion in cryptocurrency markets in mid-2017.

If the culture of ICOs is in trouble, then so too is Ethereum’s in the near future; and that seems to be supported by the move by many blockchain startups towards regulated public and private placement offerings for their capital raising effort. One idea catching on from this segment of businesses is to tokenize the actual equity (and sometimes conferring other rights) of their business in accordance with regulatory guidelines as part of a ‘Security Token Offering’ (STO), as opposed to releasing cryptocurrencies for disposable use within the business’s economy.

The advantage of these tokens is that they could allow investors earlier exit strategies through sales via security-compliant cryptocurrency exchanges compared to the generally multi-year investor partnerships required in traditional finance.

In a Security Token Offering firms would not be limited to conducting their funding raise in Bitcoin, Ether, or any other platform’s native token like the ICOs of old but could issue their own ‘coins’ or ‘tokens’ directly to investors in exchange for direct contributions of USD (or equivalent). This could mean comparatively reduced demand for Bitcoin, Ether, and others that were previously required as investment precursors — though that isn’t to say STOs wouldn’t be hosted on the Ethereum network.

This move to compliant STOs is, perhaps, a natural result of consumer resistance to the late generation of ICOs where historically around 80% have turned out to be scams, just 8% ever hit an exchange, and only 1.9% have had any semblance of success — which, ignoring the scams, is a microcosm of the failure rates that we see in the traditional business world to be fair. This coincides with a history of extreme price volatility and lacking fundamentals, a high attrition rate for weaker hands, and dumping by ICO projects cashing out their investor funds — exacerbating the industry-wide price collapse to leave their investors holding the bag.

It should come as no surprise that blockchain businesses are increasingly concerning themselves with the likelihood that they will be subject to punitive and oppressive retrospective penalties and regulations by governments of countries that they raised money from, and newer entrants are looking at ways to remain compliant with local laws.

While STOs private placement can be more cumbersome than an ICO, one positive outcome is a move to vastly increased quality, since regulated offering models see businesses (as opposed to ‘projects’) accountable to investors in providing sustainable business models, which will require avenues to actually sell blockchain products to consumers. As it stands, the majority of private equity sales never reach their funding targets, being restricted to a more sophisticated pool of investors whose due diligence process generally takes longer to make investment decisions than a one hour scan of a marketing ‘whitepaper’ that is intentionally empty of meaning and details. Investors of this ilk will be disinterested in separating with money for the sake of a token that only differentiates itself in how its internal economy functions as a financial product, which itself has no intrinsic worth.

It would appear that the innovative Initial Coin Offering is going to begin looking a lot more like traditional capital markets, before it becomes truly revolutionary.

Author: Timothy Goggin

Timothy Goggin is an economic analyst with an interest in the application of moral philosophy and decentralized systems. He studied economics at the Business School at Victoria University of Wellington, New Zealand. His area of research is the consequential and moral dimensions of implementing digital currencies and the resulting synergies for consumers in the trading environment.

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